Common Pitfalls to Avoid
Before you race off through the rest of Investing Basics, there are some cautionary points to consider before you proceed. These are common mistakes many people make when considering what to do about investing.
Doing Nothing. There is no guarantee that the market will go up the first day, month, or even year that you invest in it. But there is one guarantee: Doing nothing at all will not provide for a comfortable retirement.
Starting Late. Postponing your investing career is second only to not investing at all on the list of investment sins. You already know that the earlier you start the better off you are. (Take another look at the compound return example we gave above.) If you're already past those formative twenties (you don't look a day over 32 to us), we'll reword this first pitfall to read: "Not starting now."
Investing Before Paying Down Credit Card Debt. If you have money in your savings account and you have revolving debt on your credit card, pay it off. Many credit cards have an annual interest rate of 16% to 21%. Let's say you have $5000 to invest, but you also have $5000 debt on your credit cards with an average annual interest rate of 18%. It doesn't take an astrophysicist to figure out that you're going to have to get an 18% return after you pay taxes just to break even on that $5000. Pay the debt off first, then think about investing.
Investing for the Short Term. Only invest money for the short term that you're actually going to need in the short term. Invest money in the stock market that you won't need for at least three years, and preferably five years or longer. If you'll need your cash next year for a down payment on a house or for the family Caribbean cruise, use one of the shorter term and safer havens for your cash, such as money market funds or CDs.
Turning Down Free Money. You'd never turn down a dollar if it was offered with no strings attached. That's what you're doing if your company offers a 401(k) or similar retirement savings plan with an employer match and you're not participating. Take advantage of all tax-advantaged, employer-matched savings programs.
Playing It Safe. If you're young, most of your investing dollars should be in the stock market. You have enough time to weather any dips in the market and to reap the rewards of long-term gains. Although you may want to transition into bonds later in life as you depend on your investments for income, stocks should make up a large portion of the portfolio of every investor.
Playing It Scary. Not every investment is for everyone. We'll help you determine your psychological investing profile in Step 2. Investing Concepts. Even if you're a daredevil, you shouldn't pour all of your money into something that could end up going down the drain.
Viewing Collectibles or Lottery Tickets as Investments. If old comic books, Barbie dolls, and abandoned exercise equipment could be used to fund retirements, do you think the stock market would exist? Probably not. Don't make the mistake of thinking your jewelry, those Beanie Babies, or the lottery will provide for you in your latter years.
Trading In and Out of the Market. We believe the best approach to investing is the long-term one. Pick your investments well and you'll reap rewards over the long term that you had ever dreamed possible. Trade in and out of the market and you'll be saddled with fees that chip away at your returns, and you'll potentially miss out on gains that long-term investors enjoy with much less effort.
Sunday, June 29, 2008
Getting Started: Common Pitfalls to Avoid
Getting Started: Savings and Investment Vehichles
Long-Term Investing Vehicles
Bonds: Bonds come in various forms that you will learn about in Step 5. They're known as "fixed-income" securities because the amount of income the bond generates each year is "fixed," or set, when the bond is sold. From an investor's point of view, bonds are very similar to CDs, except that they are issued by the government or by corporations instead of banks.
Stock: Stocks are a way for individuals to own parts of businesses. A share of stock represents a proportional share of ownership in a company. As the value of the company changes, the value of the share in that company rises and falls. Stocks are discussed in detail in Step 3 of Investing Basics.
Mutual funds: Mutual funds are a way for investors to pool their money to buy stocks, bonds, or anything else the fund manager decides is worthwhile. Instead of managing your money yourself, you turn over the responsibility of managing that money to a "professional." Unfortunately, 9 of 10 "professionals" tend to underperform the market indexes, a fact that we'll look at in Step 4.
Getting Started: Savings and Investment Vehichles
Short-Term Savings Vehicles
Savings account: Often the first banking product people use, savings accounts earn a small amount in interest (anywhere from 2.0% to 4.0%, often less), making them a little better than that dusty piggy bank on the dresser.
Money market funds: Money market funds are a specialized type of mutual fund that invests in extremely short-term bonds. Unlike most mutual funds, shares in a money market fund are designed to be worth $1 at all times. Money market funds usually pay better interest rates than a conventional savings account, but below what you could get in certificates of deposit.
Certificate of deposit (CD): This is a specialized deposit you make at a bank or other financial institution. The interest rate on CDs is usually about the same as that of short- or intermediate-term bonds, depending on the duration of the CD. Interest is paid at regular intervals until the CD matures, at which point you get the money you originally deposited plus the accumulated interest payments. CDs offered by banks are usually insured.
Friday, June 6, 2008
60-Second Guide to Short-Term Savings
Could you cover the cost of a new water heater if yours suddenly went on the fritz? Would you have to put the unplanned purchase on a credit card, and then adopt a Ramen-only diet for months afterwards just to cover the tab?
Having money at-the-ready for life's financial hiccups -- both planned and otherwise -- can cut a lot of stress from your life. Give us just 60 seconds, and we'll show you how to establish a short-term stash of cash in no time.
0:60 Calculate how much you spend every month
The first rule of savings is to bank enough to cover the necessities if -- knock on wood -- an emergency arises. How much do you need? Well, how much do you spend on a monthly basis?
Add up what you spend each month on necessities such as food, shelter, transportation to work, and anything that you promised to buy your kids. (If you're not into keeping detailed records, Mint.com's free online service can give you a pretty good immediate snapshot of where your money goes.)
0:52: Add some padding for "just-in-case" scenarios
There are small emergencies (bad perm) and big ones (job loss). Bump up your monthly spending number a tad to account for things like job-hunting expenses, should you suddenly find yourself in need of a new gig. Then multiply that figure by three or six (for the number of months that you want to cover), factoring in other available monetary resources and the number of people for whom you're financially responsible.
Voila! Now you have the amount of money you need to stash in your emergency savings account.
0:48: Gaze into your 1- to 5-year "big expenditures" crystal ball
With your emergency savings covered, now it's time to figure out what other kind of cash you should put aside. Planning a renovation, extreme dental work or a family vacation? These things are also part of your short-term savings strategy. Put 'em down on paper and estimate how much these purchases will cost.
0:40: Figure out how quickly you will meet this goal
You want to fund your cash kitty ASAP (emergency expenses tend not to wait around until it's convenient). Come up with an amount you can afford to contribute each month. Make it one of those must-pay expenses -- just like your electric bill and grocery money. Yes, it's that important. Once the emergency stash is stashed, move on to the non-emergency short-term savings goals. (Use our savings calculators to crunch the numbers.)
0:37: Pick a parking spot for your cash
Easy access is essential when we're talking about emergency savings, so your money should be stashed somewhere you'll be able to get your hands on it quickly ... in case of, well, an emergency. It should also be in a "safe" investment -- meaning one that won't tank every time the stock market takes a tumble. That narrows it down to:
- High-Yield Savings accounts
- Money Market Accounts
- Money Market Mutual Funds
For non-emergency savings (where you pinky-swear to let the money sit untouched until you need it) less liquid investments -- such as certificates of deposit -- may offer you a better interest rate on your money.
0:29 Click around and comparison-shop
Look at bank ads in newspapers, check out the best national rates on Bankrate.com, see what your broker is paying on cash in your brokerage account, ask your regular bank or local credit union what they offer, and get information on money market funds from websites like iMoneyNet. Find out:
- What interest rates are available
- What are the comparable yields over identical time periods
- What timeframe the rate applies to
- What fees (if any) there are to purchase and maintain the investment
- The minimum investment required to get favourable interest rates
(Investors beware: Some institutions will offer aggressive rates in order to lure you to send them your dinero, only to lower the rates soon thereafter. Check historical rates at Bankrate.com to test the interest rates over time.)
0:17 Just do it
The clock is ticking. There's no time to waste. A short-term emergency fund is one of The Motley Fool's top money "must-haves." In fact, it may be the very thing that saves you from a long stretch of high-interest credit card debt after a fender-bender, chipped tooth, basement flood, or really unfortunate haircut.
0:03: Extra credit: Automate it!
If you're having trouble saving, we highly recommend an automatic transfer program. You can also see if your employer will split your paycheck (direct deposit) between your ordinary account and your short-term savings account, or you could set up an auto-transfer from your checking account into your emergency account.
Investing Basics: Getting Started Continued
Getting ready to invest
After seeing all those impressive numbers, you're probably itching to take the next step. You want to drop everything and start investing right now. But ho-o-o-ld on! Would you start running a marathon without first stretching? Would you pour syrup on the plate before the pancakes are done? Having dazzled you with the power of compounded returns, we want to make sure it's not working against you. This means that you've got to get rid of your high-interest debt.
Why? Because, by the very same principle discussed above, a dollar of debt can quickly compound into a few hundred dollars of debt. Does it make sense to try to save money at the same time your debts are multiplying like bunnies? The first thing you should do to prepare for investing is to pay down all of your high-interest debt, such as credit card debt. Although some kinds of debt may be low-interest or tax-advantageous (such as your mortgage), the rule of thumb is: Be free of high-interest debt when you begin to invest.
Every dollar you can put toward investing is a dollar that can work for you. And, Fool, every dollar you avoid putting in the pocket of a financial professional, a full-service broker, or a mutual fund manager, is also a dollar that is creating value for you. (We'll get back to this point later.)
Pay yourself first
How can you become a successful investor? By making investing a part of your daily life. It's not such a stretch -- money is already part of your daily routine. Think about each decision that affects your finances, whether it is ordering a $4 glass of wine with dinner or getting a home equity loan to pay down credit card debt.
We're not suggesting that you obsess over every penny you throw into a wishing well. (Please don't embarrass your mother by diving in after it.) If you pay yourself first, you won't have to. What do we mean? When you pay your bills -- the credit cards, the gas, water, electric, cable, and phone bills, and the kid who mows your lawn and the one who throws the newspaper onto your neighbor's porch instead of yours every other morning -- add one more item to that list. In fact, we think it should be the first item. Put yourself at the top of that list: Pay yourself first. Then you don't have to think about it again until next month.
The Motley Fool recommends that you put away as much as possible, with the goal being to save 10% of your annual income (total, not take-home). Depending on your obligations, you may be able to save more or less. The more you save, the more wealth you create -- but anything is better than nothing. Remember, even a few dollars saved now will be worth more than lots of dollars saved later. So take advantage of services that automatically withdraw money from your checking account and transfer it to some savings or investing vehicle. You'll be surprised how easy it is to live on a few less dollars each month. You probably won't even notice the difference.
You can be flexible about this. If you find yourself eating beans and rice every night for a month (and you don't like beans and rice), then maybe you're paying yourself too much, or perhaps you're not in a position to start paying yourself at all. But as soon as it's feasible, jump in. Remember Patrice and Bianca!
Stay tune for descriptions of Saving and investment vehicles ...
Investing Basics: Getting Started
Why invest?
Welcome to Investing Basics! If you've found your way here, chances are you've either got some money socked away or you're planning to do so. What are you saving for? Retirement? College for the kids? A new speaker system complete with woofers and tweeters? An exotic animal menagerie complete with Chihuahuas (woofers) and canaries (tweeters)? A retirement villa in the sun-baked hills of Tuscany?
Say you take $2000 of your savings and put it into the stock market. If your money returned 11% a year (the S&P 500's historical average), two grand would be worth $53,416.19 after 30 years. You could buy that Tuscan retirement villa (or at least come up with the down payment) with that kind of money.
Maybe you don't have $2000 burning a hole in your bank account, but perhaps you can afford to invest your lunch money. Brown-bag your lunch and sock away just $4 a day, 250 days a year. It's not a lot, but if you're in your early 20s, you've got the investor's best ally on your side -- time. If you invest $1,000 once a year in an investment that averages an 11% annual return -- the annual stock market return since 1926 -- it'll grow to more than $1 million after 46 years, which is right around the time you'll be ready to retire.
Of course, as you get older and more financially stable, you should be able to put away more to invest. Upping the ante to just $166 a month (lunch money plus about what you pay for basic cable TV and a movie channel), would put you at the million-dollar mark in just 39 years.
Simply put, you want to invest in order to create wealth. It's relatively painless, and the rewards are plentiful. By investing in the stock market, you'll have a lot more money for things like retirement, education, recreation -- or you could pass on your riches to the next generation so that you become your family's Most Cherished Ancestor. Whether you're starting from scratch or have a few thousand dollars saved, Investing Basics will help get you going on the road to financial (and Foolish!) well-being.
The power of compounding
The table below shows you how a single investment of $100 will grow at various rates of return. Five percent is what you might get from a certificate of deposit (CD) or with a government bond, 10% is a little less than the historical average stock market return, and 15% is what you might get if you decide to learn how to pick your own stocks . (Click the link to go to the table)
Why is the difference between a few percentage points of return so massive after long periods of time? You are witnessing the miracle of compounding. When your investment gains (returns) begin to earn money, too, and those returns start to earn... small amounts of money can mushroom very quickly. Extend the time period or raise the rate of return, and your results increase exponentially. For instance, if you start young, say at 15 years of age, note how quickly a single $100 investment grows, especially in the later years.
Looking at it another way, let's compare two teenagers and their lifetime savings habits. Bianca baby-sits a lot and spends most of her spare time reading. She saves $1000 a year starting when she's 15 and invests it in the stock market for 10 years earning 12% per year on average. After 10 years, she comes out of her shell, stops adding money to her nest egg, and spends every penny she earns club hopping and on trips to Cancun. But she keeps her nest egg in the market.
Compare her account to that of her friend Patrice, who squandered her early paychecks on youthful indiscretions. At age 40 Patrice gets a wake-up call when her parents retire on nothing but Social Security. She starts vigorously socking away $10,000 every year for the next 25 years. Guess who has more at age 65? That's right, Bianca. (You figured it was a setup, didn't you?) Her 10 years of saving $1000 per year (just $10,000 total -- the same amount Patrice put away in just one year) netted her $1.6 million by age 65. Patrice, on the other hand, scrimped for 25 years to invest a quarter million dollars out of her own pocket and ended up with just under a million. Neither will be going to the poorhouse, but you see our point: Bianca's baby-sitting money grew for 50 years, twice as long as Patrice's, and Bianca barely missed it.
(It's almost not fair to mention this, but Bianca's money was in a Roth IRA. Patrice could only put 20% of her money in the Roth ($2000 per year). So Bianca's $1.6 million is tax-free, but Patrice will be paying capital gains taxes on most of her money.)Every day you are invested is a day that your money is working for you, helping to ensure a financially secure and stable future.
Sunday, June 1, 2008
Cool Stie: Shopping Notes
Beauty More or Less
State Farms Red Portfolio
State Farm's Red Portfolio takes you from:
Getting Started which includes taking inventory, managing your money, eliminating your debt, Setting your Goals.
Reaching your Goals which includes saving for a home, getting married, Having a baby, raising your kids, planning for post-secondary education.
Planning for Retirement which includes Getting an early start, Balancing family and future, Making the most of it.
Protecting yourself which includes protecting your family, protecting your belongings, protecting your future.
Owning a Business which includes starting a business, choosing what's right, protecting your business, taking care of employees.
The Money Diaries: The Frugal Giver
Lyndsey Payzant Wells
Age: 23
Home: Los Angeles
Job: Public-Relations Asscociate
Famiy: Married no Children
Monthly Spending: $2,058
Goal: Save for a down payment on a house
Lyndsey's Monthly Outlays
Rent .................................................... $551
Car payment and insurance..................$301
Church donation..................................$230
Savings................................................$200
Gas.......................................................$153
Groceries..............................................$130
Phone, Internet, Cable...........................$96
Eating out..............................................$89
Health Insurance and expenses..............$80
Household and laundry..........................$78
Gifts.......................................................$59
Clothes...................................................$39
Grooming and beauty.............................$39
Utilities..................................................$13
The Story:Thanks to personal discipline , Lyndsey, who earns just $30,000 a year, managges to spend the bare minimum on almost everything. She packs a lunch most days for herself and her husband, Brandon, who is as frugal as she is. And she rarely shops for new clothes or indulges in beauty treatments.Still, she is willing to set aside money for things that are meaninful to her. She gives nearly 10 percent of her income to her church and puts $200 a month into savings for a down payment on a house. (Brandon is saving an additional $300 a month) she knows she should invest in the 401(k) retirement plan her employer offers but she just hasn't gotten around to it yet.
The Feedbacl by Certified financial planner Peggy Cabaniss: "Lyndsey should be really proud of her frugality," says Cabaniss. If she and Brandon continue to save $500 a month, the couple will have $25,000-enough for a down payment on a modest home-in about four years. If Lyndsey wants to have the down payment sooner, she might have to reconsider tithing 10 percent of her income until she reaches that goal, since the rest of her spending is so lean. "it's about choosing her priorities," says Cabaniss. The planner sees no major problem with Lyndsey's delaying 401(k) contributions until she and Brandon buy, especially because she's so young. Meanwhile, She shouldn't be afraid to spend a little on fun once in a while.
The FruGal does Sex and the City
12 Month New York Sales Calendar
Cheap Shopping/Fashion: Housing Works Thrift Shops
